Consumer sentiment just cratered. Here’s why that matters more than the Fed wants to admit.
KEY TAKEAWAYS
MY HOT TAKES
A sentimental journey. How you doin’? That’s how we greet each other in New York City, but here is the thing–it’s not really a question. You're supposed to answer, “how YOU doin’?” If someone from the University of Michigan’s Institute for Social Research calls you up with a similar question, they are actually interested in your answer. Those good folks at U-Mich have been conducting sentiment surveys since the 1940s, so they know a thing about collecting useful information. And you all know my favorite, their Sentiment indicator released in preliminary and final each month. It is a pretty exhaustive study that polls US households about their views on personal finances, the economy, and buying conditions. They break it all down into current conditions and expectations about the future. Also covered are near-term and long-term inflation expectations, because, if you haven’t figured it out by now, consumers care about inflation. Why? WHY? Because price is the basis for all purchase decisions! Purchase decisions, as in consumption. As in… well, you know, an obsession of mine. I am obsessed because it represents around 70% of GDP. And what is my favorite quote? Confident consumers consume. It is so simple and yet so profound.
So, what causes a consumer to be confident? Well, positive expectations about economic conditions, like personal finances, business conditions, employment, inflation, and buying conditions for big ticket items like cars, appliances, and homes. If conditions are better than they were a year ago, and consumers expect those conditions to be better yet in a year from now, well, we have conditions that are likely to yield confidence in consumers.
There is a bit of a debate around this, but I am going to tell you that consumer confidence is one of the best, if not the best, leading indicators of economic activity out there. The Fed Chairman, in his last post-policy press gathering, called them “soft” numbers because they are not an exact measure of economic activity. Soft? Maybe, but when they decline, we all feel the very real, hard impact of those numbers.
You're a consumer, right? So, tell me, without thinking too hard. Are you confident about economic conditions? I thought you would say that, and I didn’t even have to hear your answer. Now, I know that that question I just asked you was not in any way an exhaustive survey, and you alone are not a good statistical sample. But guess what, University of Michigan took care of that for us this month and it has been doing it in a similar fashion since the late 1970s, so we can observe a time series, which is a fancy way of saying we can see how it changed over time.
Let’s start with where we are now. I can sum it up in two simple words “not good.” The headline number came in at 50.1, which was down from the prior month’s reading of 57.0, and less than the 53.8 expected by economists. In fact, that 50.1 reading was the second lowest since this version of the indicator has been around. Its stinkiness 🦨was only rivaled in June of 2022, and by only a hair. Prior to that, you would have to go all the way back to 1980 to get anywhere close. Why don’t we just have a look at the data on a chart dating back to the late 1970s. Have a peek and follow me to the close.
You can see on the right-hand side of the chart how the index bombed during those high-inflation, aggressive Fed, market losing days in 2022. Sentiment improved however, once the Fed flipped into rate-cutting mode, the market recovered, and the US voted in what was expected to be a pro-business, pro-market President, only to quickly crumble through last Friday’s release. Now if you zoom out, you will notice that I added red-shaded areas for US recessions, and it should be quite clear to you that sentiment trended lower and, in most cases, spiked lower ahead of recessions.
So, does this downward spike in sentiment portend a recession? Well, no, not exactly. You may notice that there were plenty of downward spikes in sentiment that were not followed by a recession. But we can safely conclude that declines in sentiment are always present when a recession does occur.
Now, you may not be surprised that some critics of sentiment indicators say that they are politically biased. If you look at responses broken down by political party, you would, in fact, find that republicans tend to be more optimistic during republican presidencies and vice versa. That said, while democratic respondents reflected the biggest recent declines amongst the two parties, republicans’ sentiment is on the decline as well. If we just do the simple math, we now know that around 45% of voters have experienced a significant decline in consumer confidence, and another 46% have also lost confidence, but with lower intensity. That former assertion was enough for me to know that there is some serious damage that has been exacted on the US’s economic health in recent months. Oh, and did I mention that this survey took place prior to the liberation day announcement which sent markets in a tailspin? That means that if the survey were done today, it may even look more dire.
Folks, these sentiment number declines are a real problem, and it is all directly linked to the uncertainty fomented by the administration's trade crusade. Thankfully, in recent sessions, the President has shown signs that he may be seeking to negotiate some solutions, but unfortunately, ambiguity around what the President is actually seeking and for how long these reprieves will last, will continue to keep consumer sentiment in a weak state. Now, there is some good news, if you can even call it that. While it is clear that some irreparable damage has been caused, it is not too late to turn things around. How do I know that? Because, as stated earlier, there have been many instances where declines in confidence did not lead to an immediate recession. Now that consumer sentiment has declined significantly, we need to watch the so-called “hard” numbers that would be more directly tied to consumption. We will get Retail Sales from the Census Bureau later this week. That is an important number, however, based on the front-loading purchases being made ahead of the tariffs, we may see gains before we see greater losses. At the end of the month, we will get Personal Spending which will give us another more direct-link indicator of GDP. That number has already been displaying weakness, and we will have to see if that continues. For now, heed the warnings of the real drivers of the US economy–ignore them at your peril.
FRIDAY’S MARKETS
Stocks rallied on Friday in the wake of solid bank earnings as investors chose to be “cautiously optimistic” that the President is ready to start negotiating and ease up on the rhetoric. Sentiment hit another low point last month according to the University of Michigan’s preliminary sentiment release.
NEXT UP
DOWNLOAD MY DAILY CHARTBOOK HERE 📊